Posted on 01/12/2008 8:29:47 PM PST by TigerLikesRooster
China can no longer delay action on rates and yuan
Standing before China's central bank in Beijing it's hard not to feel as if you are at the center of the universe.
Londoners, New Yorkers and Tokyo residents may object to that characterization, yet perhaps no institution will be more in the spotlight in 2008. While the Federal Reserve in Washington, the European Central Bank in Frankfurt and the Bank of Japan in Tokyo will do their thing, events in Beijing may matter most.
The next 12 months will force the People's Bank of China to make prickly decisions it has been putting off for years. They include bigger interest-rate increases, accelerating the yuan's rise, loosening the capital account and what to do with currency reserves that are $1.4 trillion and growing.
A major change in any one of these policies will have wide-ranging repercussions a world away. Changes in a number of them simultaneously could mean a sharp increase in conference calls among Group of Seven officials and investment-bank executives.
Waiting is no longer a luxury following a 6.9 percent surge in consumer prices in November from a year earlier. It was the biggest jump since December 1996 and heightened concerns that the world's No. 4 economy may overheat.
China`s yuan fell, slipping from the strongest since it scrapped a peg to the dollar in 2005 on speculation the central bank is seeking to deter investors betting on further gains. [Bloomberg]
"Beijing is becoming ever more concerned about domestic inflation," says Stephen Green, economist at Standard Chartered Plc in Shanghai. Inflation will force China to let the yuan gain 9 percent against the dollar this year and 7 percent in 2009, he says.
While that may not make U.S. Treasury Secretary Henry Paulson completely happy, it's an admission of reality. Even with the benchmark one-year lending rate at a nine-year high and a slew of administrative actions, Chinese growth probably accelerated in 2007 to the fastest pace in 11 years.
There's now considerable concern about China exporting inflation. For years, disregard for the environment and negligible protections for workers kept production costs low. Worsening pollution and labor unrest are forcing China to normalize costs.
Yet domestic inflation may get even more attention. Public anxiety over surging prices of everything from oil to pork to grains to electricity is rising. According to a recent study by the Chinese Academy of Social Sciences, about half of poor families' income already goes to food.
House prices in 70 major Chinese cities, meanwhile, jumped 10.5 percent in November from a year earlier. The CSI 300 Index climbed 162 percent last year. China's trade surplus surged 52 percent in the 11 months through November to $238.1 billion. The combination of asset bubbles and rising prices of basic necessities can no longer be ignored.
What China needs is a bit more Paul Volcker and bit less Alan Greenspan. Volcker's charge as Federal Reserve chairman between 1979 and 1987 was breaking the back of inflation. Greenspan's job (1987-2006) was to give the economy room to roam. Often, Greenspan went too easy, creating bubbles.
Until now, Chinese officials seemed more content to let the economy roam rather than clamping down on things. China's broadest measure of money supply grew 18.5 percent in November, faster than the central bank's 16 percent annual target.
China is paying the price for what economist Nouriel Roubini, chairman of Roubini Global Economics LLC in New York, calls the "impossible trinity." An economy can't simultaneously manage its exchange rate, control domestic liquidity and open its capital account. China seems to think it can do just that.
When you hold down a currency, as China does by accumulating reserves, foreign-exchange inflows boost the money supply. China tries to "sterilize" things by taking steps to neutralize the effects of rising reserves on money growth. That's easier said than done when your reserves are well above $1 trillion.
It really is time for China to get out of this bind. One way China mops up liquidity is with bond sales. Such sales drive up interest rates and attract more capital flows, increasing the risks of overheating. The Federal Reserve's rate cuts also are sending liquidity China's way.
The same is true of raising interest rates. Higher rates are just increasing the appeal of Chinese assets.
Another decision that can no longer be put off involves reserves, especially given the geopolitical implications. "Poor" China is sitting on the world's biggest stockpile of currencies and using them to buy into Blackstone Group LP and Morgan Stanley. Yes, China is a developing nation, but, as the world is increasingly realizing, one with extraordinary means.
Traders see China's great wall of reserves as a strength. It's really a failure that gets to the heart of China's weaknesses. Holding down the currency helps exporters, though it also restrains household purchasing power. The policy undermines the development of a vibrant domestic economy.
Any shift in reserves is likely to have wide-ranging repercussions for the dollar, global interest rates, other large holders of U.S. assets in Asia and the Persian Gulf and trends in markets everywhere.
According to the Chinese zodiac, this is the Year of the Rat. For officials in Beijing, it's really the year of the big decision.
btt
They should hold off as long as possible, if for no other reason as to make Paulson look like the Kowtowing fool he is.
History has shown that free and open markets work best to improve the human condition. The faster we force China to accept this reality the better off the world will be.
The belief that economies overheat is another piece of garbage that came out of Greenspan's mouth, and is now considered gospel by the press.
Reagan's policies broke the back of inflation. All Volcker did was create a near depression.
I find it incredibly difficult to take anything William Pesek writes seriously any longer. He’s long since demonstrated himself an ardent Asia-phile and only thinly veiled doomsayer for the United States.
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